Back in 1972 there was a disaster movie called the Poseidon Adventure. A luxury cruise went horribly wrong, the ship turned turtle and the rich passengers had to escape somehow from their upside-down world. Coincidentally, a year later, the world economy went belly up.

This year sees the remake, Poseidon; shorter title, same idea, similar plot, better special effects. And, what do you know, the good old world economy is again threatening to replicate art (sic) by capsizing. Governments everywhere have been put on notice by the International Monetary Fund that sorting out the global imbalances is a top priority, as indeed it is.

Most of the attention has been on the US trade deficit and China's undervalued currency. Europe tends to be left out, because, taken as a whole, the eurozone looks to be pretty much in balance. Growth is a bit weak, domestic demand even more so, but there is no evidence that the continent is living well beyond its means. That, though, is something of an illusion. Within the eurozone, there are imbalances that are a microcosm of the global economy. Germany is the country that has the competitive advantage over its partners; Spain the country with the US-style profligacy.

Costa del Sol

Spain is a particular concern. The IMF, in its annual health check last week, noted that growth had become "increasingly lopsided" and that was reflected in higher inflation than the 12-nation eurozone as a whole and in a rising current account deficit. In truth, the IMF assessment is a bit of an understatement. Spain's current account is on course to hit 9%-10% of GDP next year; its private sector has moved from a position where it was in surplus by 6% of GDP in the early 1990s to a position where it is in deficit by 8% of GDP. These are bigger deficits than those of the US. Spain has been growing much faster than the rest of the eurozone; indeed, without Spain, Europe's recent growth record would have been even poorer. Charles Dumas, of Lombard Street Research, noted last week that Spain accounts for around 12% of the eurozone economy, but between 2000 and 2005 it accounted for 32% of eurozone GDP growth and 39% of eurozone domestic demand.

Most of this growth came from a construction and property boom, which has masked a deeper problem of increasing uncompetitiveness. Spain's unit labour costs have been rising much faster than elsewhere in the eurozone and productivity has been poor. Traditionally, there would be two ways of coping with this problem: the Spanish government would raise interest rates to choke off speculation in the construction sector or there would be a sharp fall in the peseta to make Spanish goods more competitive. Neither, of course, is open to Madrid, which signed up for the euro when it was launched. As Mr Dumas rightly noted, the lack of any policy instruments means the property boom will go on until it collapses under its own weight. There is no knowing when this will be but - UK home owners on the Costa del Sol, please note - when it does it will be mightily painful.

The other side of the coin is Germany. Paul de Grauwe, economics professor at the Catholic University of Lauven, gave a presentation at Dresdner Kleinwort Wasserstein last month in which he warned of beggar-my-neighbour wages policies across Europe. The de Grauwe argument goes as follows. Germany joined the euro at a disadvantageous exchange rate and has spent the last decade making its goods more competitive through low wage increases. This hard-won advantage has been at the expense of other eurozone members, who, given the lack of policy freedom, will have to respond by cutting their own labour costs. A vicious circle would ensue if the Germans responded by a second round of cost cutting. Given that Europe has a problem of weak consumer spending, this is obviously not an attractive scenario, but one that looks possible given both the lack of macro-economic leeway for countries such as Spain and Italy, and the current fetish for flexibility as a solution to Europe's problems.

Dire predictions

Interestingly, Mr de Grauwe said he had failed to find a statistically significant relationship between product market regulation and GDP or productivity growth. Too much competition, he posited, might be bad for innovation and growth since companies needed the incentive of economic rents (returns above those available in fully competitive markets, in other words) in order to bring new goods to market.

Nor could Mr de Grauwe find a statistically significant relationship between labour market reform and productivity growth. There was a link between labour market reform and overall growth, but it explained only a small proportion of the variation in growth between two countries.

Three conclusions emerge. The first is that some of the claims made for deregulation and flexibility as a cure-all for Europe's ills need to be re-examined. In this context, last week's Employment Outlook from the Organisation for Economic Cooperation and Development made the point that there was no single way to achieve high employment. Many countries with low unemployment had done so while having extensive labour market regulation.

The second conclusion is that Europe is in urgent need of some new policy tools or at some point a country that finds further cuts in wages to regain competitiveness politically untenable is going to plump for the nuclear option and leave monetary union. For Mr de Grauwe, there were two possibilities: wage co-ordination at the eurozone level (which looks highly improbable) or the liberalisation of wage setting so that they were set by demand and supply on a firm-by-firm basis (ditto).

So what's the third conclusion? This emerged from a speech by the new economic secretary to the Treasury, Ed Balls, last week. Balls, who was instrumental in establishing the five economic tests for UK entry into the euro when he was Gordon Brown's chief economic adviser, is now responsible for the City, and he made the point that the dire predictions about London becoming a financial backwater outside the eurozone have proved false. Neither, for that matter, have any of the other scare stories peddled by the pro-euro lobby come to pass either. The UK has not ceased to be an attractive place for investment. And the UK has not lost influence. Indeed, it is hard to remember a time when a British chancellor had more influence on European economic policy than Gordon Brown, and that is the result of being outside not inside the malfunctioning eurozone.

Mr Brown and Mr Balls take great satisfaction from this, as well they might. It was a brave, and correct, decision to face down the euro-fanatics in 1997 and 2003 and, for once, insist that politics had to be subservient to economics. Had Britain joined, we would have had a Spanish-style property boom followed by an almighty crash. Lacking the political commitment to the euro shown by Spain and the other founder members, Mr Brown was concerned that a catastrophic boom-bust cycle would have led not only to pressure for withdrawal from the euro but secession from the European Union. And he is absolutely right, because that is what would have happened.